thoughts on GD (yes, covered by the exam along w/ the Nikkei incident, sigh)

So how DID the Great Depression happen?

Some say that GD was cause by the stock market crash of 1929 but not so. A recession had started before the crash, and other factors played a central role later in the depression.

But crash was still important!

Crash was not caused by the sudden realization that a depression was coming . no evidence in the papers of 1929. Source of crash was almost surely the end of a speculative bubble.
The crash not only decreased consumers’ wealth, it also increased their uncertainty about their future.
Nominal money stock went down: coz M=H x money multiplier.
M=currency +checkable deposits
H=money base, currency+ bank reserves
Side note: CB holds credit and cash; cash=C(held by public) and R (held by bank=reserve)
M=C+D (D=deposit at CB)
Assumption: C=cM (where c=constant)
                           D=(1-C)M
                           R=θD=constant amount of deposit in the form of reserves
                        R=θD=θ(1-C)M
               àH=C+R

=cM+θ(1-C)M

=[c+θ(1-c)]    (θ=less than 1)

àH=(c+θ(1-C)M and M=(1/1+θ(1-c))H

M=1/(c+θ(1-c)H where c is the proportion of M ppl want to hold as currency, and θ=ratio of reserves to checkable deposits. The higher c, the lower the multiplier.
If c=1, ppl want to hold only currency, Multiplier=1
Money multiplier declined: coz of bank failures. (with decline in Y, more borrowers were unable to repay loans and more banks closed down)
Bank failure affect Ms: ppl shift checkable deposits to currency. Multiplier=1àdecrease in nominal M stock. àdecrease in P level, à real money stock remained constant, eliminating one of the mechanisms that could have led to a recovery.
LM did not change, not shift down as it would have done if the nominal money stock had remained constant, implying an increase in the real money stock.
àthe Fed was responsible for the depth of the GD: it is not directly responsible for the decrease in the nominal M supply but it should have taken steps to offset the decrease in M Multiplier by expanding the monetary base much more than it did.

If I had learned ANYTHING in studying Macroecon, it is that ppl are stupid enough to sometimes make REALLY BAD choices...for themselves and others...